economy Markets stocks

Falling Knife Catchers Anonymous (Containment Zones)

Then again...

“It’s not quite time to buy”, one guest mused, on Bloomberg TV Tuesday afternoon, as US equities oscillated and investors anxiously awaited details from the Trump administration on the White House’s plan to help cushion the economic blow from the containment measures associated with the effort to prevent the spread of COVID-19.

Apparently, Trump told GOP’ers he’d like to see payroll taxes waived through the election in order to ensure that any temporary, COVID-19-linked holiday doesn’t expire just in time for Americans to notice the hit to their paychecks and vote him out of office. That’s according to sources who spoke to Bloomberg.

In Italy, virus deaths topped 600 and cases reached 10,000. The country is now totally locked down. Luigi Di Maio told Rai the government is considering measures including the suspension of mortgage and tax payments. Air France said Tuesday it’s suspending all flights to and from the country from March 14. The government is actively pondering whether to demand it be allowed to lift its deficit to just under 3% of GDP in order to pave the way for some €16 billion in stimulus.


In New York, Andrew Cuomo announced a one-mile “containment zone” around New Rochelle that will last until March 25. The National Guard will be deployed to help with food delivery. “This is the single greatest public health challenge we have in the state right now”, he said. A 69-year-old man from Bergen County, New Jersey, became that state’s first fatality.

Harvard told students not to return to campus after spring break, and MIT is beginning to move some classes to the virtual realm.

In China, Xi visited Wuhan, which clearly suggests the threat is receding in the original epicenter of the epidemic.

When it comes to the market and economic fallout, the US is just beginning to feel the heat, and there is perhaps no better story that encapsulates multiple dynamics than news that Occidental Petroleum is slashing its dividend for the first time in three decades.

“Due to the sharp decline in global commodity prices, we are taking actions that will strengthen our balance sheet and continue to reduce debt”, Vicki Hollub, Occidental’s President and CEO said Tuesday. “These actions lower our cash flow breakeven level to the low $30s WTI, excluding the benefit of our hedges, positioning us to succeed in a low commodity price environment”.

As Bloomberg notes, the company is looking “to conserve cash to cover debt incurred in its $37 billion takeover of Anadarko”, a deal which left Occidental as “one of the most-exposed major oil explorers to declining crude prices”.

There’s a long backstory there and industry analysts can debate the finer points until the cows come home, but at a macro level, this represents the collision of rising corporate debt, M&A, a biological black swan and a geopolitical earthquake. In other words, Occidental’s payout cut is a kind of microcosm.

This perfect storm will probably end up engulfing dozens of US corporates and, as documented extensively here over the past couple of weeks, there is virtually no chance that profit growth is going to stage the kind of rebound consensus had baked in following the Q3/Q4 2019 shallow earnings recession.

Read more: For One Bank, A Global Recession And A Bear Market Just Became The Baseline Forecast

“From a fundamental perspective, the market has simply moved from pricing in earnings growth of more than 20%, which would have easily been the fastest of this cycle, down to now pricing in flat earnings”, Deutsche Bank said, in a special report on the outlook for the global economy and markets given the evolution of the epidemic. “It has yet to price in any drops in earnings from the expected slowdown in activity”, the bank went on to remark.

Their base case was for a 20% decline in US equities from the records hit last month, with a downside to 30%. That call was made before Monday’s plunge.

On Monday evening, Goldman said global equities will probably fall 20-25%. The good news is, the MSCI All-Country World is already down – checks notes – 18%. So, not much further to go now.

Checking in on JPMorgan’s market-implied recession odds, as of Friday, 5-year US yields were pricing in a 94% chance of a US downturn.

US high yield and high grade spreads, as well as equities, were more sanguine.

Do note that the input for HY was 586bps. On Bloomberg Barclays’ index, spreads ballooned out to 642 on Monday. The average during the past three recessions has been around 1,000. Obviously, equities have declined precipitously since Friday afternoon, so those probabilities may well be higher now.

For those of you so inclined, the following two visuals may suggest a good dip-buying opportunity.

Then again, those images may just be an invitation to catch a falling knife, only to land yourself in the emergency room alongside someone waiting to be tested for COVID-19.

Thusly exposed, your next stop may be a “containment zone”.


 

4 comments on “Falling Knife Catchers Anonymous (Containment Zones)

  1. Anonymous says:

    Heard an interesting point from a pro today…

    A sharp widening in Investment Grade credit spreads should, by logical extension, signal a reduction in the P/E’s that equity investors will be willing to pay.

    That is, if you’re demanding more risk premium for the debt, then you’re sure as heck going to demand more risk premium to own the equity.

    So, if IG spreads remain wider, then we have to apply lower P/E’s to the lower E’s that Walt references in this post.

    I now remember why equities tank 25-40% during recessions. One-Two punch of lower E’s and lower multiples.

  2. mfn says:

    “Fast Money” traders were talking about this tonight. Seymour said it’s signaling a likely bottom at S&P ~2,740. A non-regular on the panel was suggesting lower (but not 2,350 Dec. ’18 retest low). FWIW, I’m betting on a retest of the December low. Went out to dinner tonight in NYC. Coronavirus was all people were talking about. Lots of talk about canceling travel plans and fingers crossed that the news doesn’t get worse. Way too much uncertainty out there to say we’re close to the bottom.

  3. hookandgo says:

    H-Man, the market still can’t price the virus. Methinks, the storm is just brewing. This is like a hurricane coming in at CAT 5 and it looks like a direct hit.

  4. Bas says:

    Yeah, I agree with Goldman. I see higher volatility for a while, at least until options roll off and aggregate gamma flips positive. Maybe another 5-10% downside through it all, but promises of stimulus will likely limit the downside. There are still some good trading opportunities with short term directional option bets. Buying puts today.

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